A SIPHON FOR PETROL PRICE PAIN

Thursday, July 4, 2013

A siphon for petrol price pain

This morning the price of West Texas Intermediate oil is at a 14-month high above $US101 a barrel. At the same time, the Australian dollar is floundering near a three year low of $US0.9060 which means that the Australian dollar price of oil is rocketing higher.

Already we have seen the price of petrol in Australia rising and it is set to increase further. There is near consternation with TV news, newspaper and online news services giving the "pain at the petrol pump" stories top billing.

Petrol prices are increasing because the world oil price in US dollar terms has been rising for the last few months and because of the obvious fact that the Australian dollar has been falling pretty much consistently for the past three months. At around current levels for world oil prices and the Australian dollar, the national average petrol price is likely to rise to around $1.65 to $1.70 a litre within the next month or so. This is around 20 per cent higher than at the start of the year.

This rise is big and is occurring rapidly, to be sure, but even allowing for this surge it means that petrol prices will be around 30 per cent higher in total than at the start of 2006 (for example), which compares with an overall increase in the inflation of just over 20 per cent over that same time frame.

The other context for this latest petrol price surge is the fact that average wages have risen by a touch more than 30 per cent since the start of 2006, meaning that the "pain at the petrol pump" is more likely to be illusory rather than real. Or perhaps the recent price jump is based on the fact that petrol prices were very cheap at the start of the year and what we are seeing as global oil prices rise and the Australian dollar falls is some sort of correction from what was an unusually low level.

The other issue to consider is that petrol makes up 3.5 per cent of spending for the average household, according to the weights used by the Australian Bureau of Statistics in the compilation of the consumer price index. The average household spends almost double that amount on meals out and takeaway foods, coffee and soft drink. The average household spends double the amount it spends on petrol on alcohol and tobacco, yet we rarely see headline of "pain at the drive through" when hamburger and skim latte prices have increased or "pain at the pub" when the price of a poor quality sauvignon blanc rises to $8.00.

This is not to say that the impact of higher petrol prices will not be seen. Indeed, in earlier bouts of petrol price surges there has tended to be a dip in consumer confidence and growth in other retail spending slows. Unlike takeaway food, for example, spending on petrol is quite inelastic – that is, people must buy a given amount almost regardless of the price, at least in the short run.

A jump in petrol prices is seen as a contractionary influence of the economy – 'a tax on growth' is a phrase that will do the rounds no doubt as petrol prices continue to rise. What also has occurred in past when petrol prices have jumped sharply is a dip in new car sales and a skewing towards sales of small or more fuel efficient cars. Expect this to occur again in the months ahead.

It is difficult to be sure where the global oil price and the Australian dollar will move to and whether there will be yet higher petrol prices in the months ahead. The turmoil in Egypt is seen as a factor behind the more recent spike in global oil prices – that is, prices are up on the risk of a supply shock, rather than prices being driven by stronger demand.

These sorts of events tend to have only a relatively short run effect on oil prices – the oil is still there, it is just the temporary supply issues that are impacting and these will likely fade once the political issues subside.

In terms of the Australian dollar, every person and their dog is now bearish, including the Reserve Bank Governor Glenn Stevens. There seems little doubt that the Australian dollar will continue to depreciate, which will put a floor under petrol prices for a while longer.

In the end, no-one likes paying more for anything, petrol included. People love low prices and they recoil when prices rise. It is natural. The petrol price rise is large, but it needs to be kept in context of other items consumers buy, wages growth and the benefits the lower Australian dollar and higher global energy prices will have for Australia's national incomes, jobs and longer run prosperity. Local energy companies are no doubt delighted to see oil prices rising.

Even if it hurts a bit to be paying an extra $25 or so each time you fill up the car, think of the boost to exports, jobs and the local economy that fall in the Australian dollar is delivering.